Q: My son is a junior at Johns Hopkins University and has been renting an apartment in an excellent location. Recently the apartment building went condominium and my son and his roommate have an opportunity to buy their apartment. Questions: (1) Is it feasible for the two of them to buy the apartment together? (2) Would you feel this is a good investment, considering the fact that the boys will have only another year in school? It is an excellent location for rental to students, but should there be something in the sales agreement that says the boys are free to rent to students?
A: First, it's feasible for them to buy the apartment together. I suggest they take title as tenants-in-common, not as joint tenants. Consult your real estate attorney for further advice on this and other possible legal questions.
Second, information I have leads me to conclude it's probably not a good investment. Rental rates for condo apartments such as these young men would buy are not sufficient to afford a positive cash flow. In other words, the rent they'd get wouldn't cover the mortgage payments and necessary operating expenses, at least for several years. After several years (assuming inflation continues at about its present level and assuming they'd have a level payment mortgage), they probably would begin to break even. Eventually, they'd get a positive cash flow. But even then, the yield on their investment (including appreciation, equity build-up and tax-deductible depreciation) might well not equal that on another type of investment.
If they decide to buy, nonetheless, it would be wise to put a clause in the sales agreement allowing them to rent to students. Your attorney can advise more fully on this.
Q: It seems to me that I remember seeing in one of your columns how the value of a lease may be computed. One of my colleagues says there's no such thing as the value of a lease as such. May a lease have value for the lessee? Can you compute that value?
A: Yes to both questions. To compute the value of a lease, compare the annual rent you're paying (called contract rent) with the annual rent for comparable space or proerty today (called market or economic rent). If the annual rent you're paying is less than market rent, the lease has value. If the annual rent you're paying exceeds market rent, the lease is valueless from your (the lessee's) viewpoint. In fact, from the an economic standpoing, it's an unsatisfactory lease for you. Here's an example: Suppose you've just negotiated a five-year lease on 10,000 square feet of office space at $8 per square foot. Comparable office space rents for $9 per square foot today. You compute the value of your lease this way:
Annual market rental $90,000
Your annual rental $80,000 our annual savings $10,000
Present worth of $1 per year for five years at 10 percent is $3.79 (from compound interest and annuity tables).
Value of your lease
$10,000. x $3.79-$37,900.
Q: Can a mortgage company be forced into discounting an existing mortgage? My mortgage on my home is at a 6 1/4 percent interest rate. But I believe I'd like the feeling of security owning my home will give. During a conversation with the agency servicing the loan, I was told the lender discounts mortgage notes but wouldn't discount mine because it didn't fit his discount criteria. Also, he felt that anyone considering a total payment of a $22,000 balance would probably do so even without a discount. Can a lender select only certain loans to discount and disregard others?
A: Yes. The mortgage note is a contract between you and the lender. It's binding on both. If you want to change the obligation (as you do when you want to prepay it, with or without a discount), the lender can refuse to change it (allow repayment) or can allow you to change it only on certain conditions. In this case, the lender says he'll accept prepayment but only on a no-discount basis. This is not improper or illegal. The lender probably takes this position for what he thinks are good reasons.
On the other hand, you can refuse to allow the lender to make any changes. For example, if a lender suggested an interest rate of 9 1/2 percent but a longer term - so that, perhaps, your monthly payment would be smaller than your present monthly payment - you could refuse and hold him to the present 6 3/4 percent interest rate.
There are several reasons a lender might agree to give a prepayment discount in the case of a particular mortgage note or class of mortgage notes, and refuse to discount another, or other, classes. An explanation of the reasons is too lengthy for this brief space. But any sophisticated lender can explain the principal involved.
Q: Our investment group recently purchased a rental apartment building 15 years old for approximately $1.2 million. What is the maximum depreciation we can deduct each year?
A: On the depreciable part of your investment (building and other depreciable improvements, if any, but not land) you can use 125 percent declining balance depreciation providing (1) it has a useful life of 20 years or more (it should have) and (2) 80 percent of the gross income from the building is rental income from dwelling units (you can include rental value of space occupied by the owner). If the property isn't eligible under these criteria, you'll have to use straight line depreciation.